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By John Helmer, Moscow

Uralkali, Russia’s potash monopoly, has been spending heavily for months – more than $1.3 billion — not so much to buy back its free-floating shares, as to let its control shareholders escape. The cash has come from new bondholders and from state banks, Sberbank and VTB. Bank of America Merrill Lynch and Goldman Sachs have played along helpfully, too.

Since Tuesday, July 30, we know why. That’s the day Uralkali announced to the rest of its shareholders that it was leaving the Belarusian Potash Company (BPC), the long-time export joint venture with Belaruskali, the Belarusian producer, and abandoning production and marketing control in order to support the potash price above $400 per tonne. In short, bye bye BPC — hello potash at $200 per tonne.

At that price, Uralkali imagines it can ramp its mine output of potash up to maximum; lower its unit costs; and beat everyone else in the market to sales. What this does to Eurochem, owned by Andrei Melnichenko (image, lower right), is not so positive. Although potash sales amount to zero on Eurochem’s current balance-sheet[1], it is planning to produce and sell 8.3 million tonnes a year, putting Eurochem a close second behind Uralkali’s current production level between 10 and 11 million tonnes. Since 2011, when Uralkali took over Silvinit, the second active Russian producer of potash, Belaruskali has been producing between 9 and 10 million tonnes per annum. This year, according to announcements before last week, Belaruskali is planning on a one million tonne increase, or 10% annual growth in production.

The Eurochem threat to Uralkali’s sales strategy is not less than the threat from Belaruskali. But Eurochem has also acknowledged that its cost and profitability calculations require potash to stay well above where Uralkali’s action is putting it. “When we studied the profitability of this project,” Eurochem chief executive Dmitry Strezhnev has said[2], “it was profitable even at a potash price of $500. We do not expect prices to go lower than $700-$800, so our investments carry almost no financial risks.” What chumps Uralkali is making of Melnichenko and Strezhnev. Should they have suspected in advance what was going to hit them on Tuesday?

In September 2011, Uralkali’s chief executive Vladislav Baumgertner told[3] an Indian newspaper: “we follow a global pricing policy that is determined by supply-demand balance and not cost of production. Currently, all potash producers are operating at near full capacity and the options for brownfield expansions are limited. Greenfield investments will not come unless manufacturers get a net-back (ex-factory) price of $450-500 a tonne.”

At the time, Uralkali told the Indians it was planning soon to invest $2.5 billion over five years to add 2.5 million tonnes per year in new mine production. At that point, two years ago, the table below indicated how the global potash market appeared in terms of annual production, with the North American exports controlled by Canpotex, and the Russian and Belarusian exports by BPC. For more on how these cartel arrangements have been evolving until now, read the archive[4].

Source: Hindu Business Line

From last week Uralkali says it has decided to go on the market offensive, alone against both Belaruskali and against the Canpotex alliance. So there is reason to suspect that Melnichenko’s ambition to become a major potash producer on his own – counting both Eurochem’s new Russian mines and Melnichenko’s 10% stake in K+S – is doomed; and that he too is a target of the new Russian strategy. Is Suleiman Kerimov (lower left), the control shareholder of Uralkali, planning to oblige Melnichenko to halt his new Russian mines, abandon his promised Kazakh projects, and force Eurochem to sell out to Uralkali?

Melnichenko’s spokesman in Moscow Vladimir Torin, and his London public relations firm FTI Consulting, were asked whether he and Eurochem had advance inkling of Uralkali’s change of strategy, and what change of strategy they plan themselves now. They refuse to answer.

At its most optimistic – according to a study released by Renaissance Capital (Rencap), which is partly owned by Kerimov — sales revenue for Russia’s current potash monopoly will rise on a 50% increase in production, though earnings will dwindle as the potash price falls, and net profit will be cut in half from last year’s bottom-line of $1.6 billion. The cash position of Uralkali will go from a positive $1.1 billion in 2012 to a negative $961 million this year. The debt to earnings (Ebitda) ratio will jump from 1x in 2012 to 3x this year.

The good news, according to the report by Rencap analyst Boris Krasnojenov, is that as potash prices collapse towards $200 – the Rencap prediction is $258 per tonne this year, $224 in 2014 – most of the higher-cost potash produces in the rest of the world will fail to find customers; new mines will be shut down; and the Chinese, Indians and Brazilians, who dominate the potash consumers’ market, will lift their import volumes. When that happens, Uralkali will have taken a much larger market share and be able to capitalize on the potash price growth disproportionately. “We support management’s decision to change strategies,” writes Krasnojenov, “and terminate its [share] buy-back programme… The reduced potash supply in the future may support potash prices later this decade, while Uralkali’s new strategy may help maximise its market share.”

The official Uralkali statement of July 30 claimed: “Unfortunately, we should state that our cooperation with our Belarusian partners within BPC framework has come to a deadlock. It has always been Uralkali’s position that export activities of both producers should go through the unified sales network. This fundamental principle of partnership was violated by the Decree No.566 issued by the Belarusian President [Alexander Lukashenko] on 22 December 2012, which cancelled the exclusive right of BPC to export Belarusian potash. Following the issue of the Decree, Belaruskali has made a number of deliveries outside BPC.”

Seven months since the Minsk decree is a long time in potash politics. For years before that, in fact, Uralkali has known, as has everyone in the potash market, that Lukashenko and his son, Victor, (right) have been authorizing special cargoes of potash for export outside the BPC arrangement.

Also, Kerimov had been to talk to Lukashenko more than once in the interval – as publicly
announced on December 28, and again on May 20.The Belarus television footage of their second meeting reveals the assertive Lukashenko lecturing the timid Kerimov:

[5]

Belarus television showed Kerimov’s lips moving – something almost never shown on Russian television by Kerimov, a senator for the Dagestan Republic in the upper house of the Russian parliament. Nothing he said can be heard, however.

According to the latest announcement from Uralkali, Kerimov was just pretending to be timid for the Minsk television camera. In fact, says Uralkali’s July 30 statement, off-camera with Lukashenko he got tough indeed. Claims Uralkali: “we have repeatedly informed our Belarusian partners that such actions were unacceptable and they have ultimately destroyed the fundamentals of our prolonged fruitful cooperation. In this situation we have to re-direct our export deliveries through our own trader. Still, we thank our Belarusian partners for cooperation within the BPC framework and do not exclude the possibility of cooperation on a mutually beneficial basis in future.”

It sounds like Kerimov warned Lukashenko not to increase output and sales outside the BPC, and threatened him with a break with the BPC. On July 31, the day after the break, Belaruskali claimed[6] it had not been “consulted”. There are also reports in Moscow that Kerimov has been pressing Lukashenko to accept a merger between Uralkali and Belaruskali: Kerimov’s price is reported to have been $15 billion; Lukashenko has reportedly asked for $30 billion. But that was before.

Kerimov holds 17.2% of Uralkali’s stock and directly controls 4 of the current 8-member board of directors. He has issued his own statement[7], implying that Uralkali’s decision might have been known to the insiders well before the announcement: “We also have high regard for the level of corporate governance at Uralkali and intend to continue to be actively involved in the work of the Board of Directors and its Committees, cooperating with the representatives of all shareholders to make decisions ensuring the long-term sustainable development of both Uralkali and the global potash industry.” In case Kerimov himself might be suspected of shorting the stock, when he knew it was about to fall, the statement claimed: “Our purchase of a stake in Uralkali in 2010 was a strategic long-term investment for Nafta Moskva. We view the fundamentals of the potash industry as strong and have confidence in the growth potential of this market, which makes the investment in Uralkali extremely attractive. Nafta Moskva supports Uralkali’s new strategy, considering it to be in accordance with the interests of all stakeholders and aimed at maximising shareholder value.”

Wadge Holdings has been a combination of Kerimov, Filaret Galchev, Anatoly Skurov, and until he sold out recently, Zelimkhan Mutsoev. The story of how this combination, plus Alexander Nesis, got together, and with VTB financing acquired Uralkali from its former owner, Dmitry Rybolovlev, and then merged with Silvinit in 2010, was told here[8]. How Mutsoev combined again with Kerimov at the start of this year, and again with state bank money bought Mikhail Prokhorov out of Polyus Gold was told here[9].

Mutsoev’s reward for borrowing so heavily from the state has been to exit profitably, and of course patriotically and philanthropically. Last November, Kerimov, Mutsoev & Co. sold an option[10] for the Chinese sovereign wealth fund, China Investment Corporation (CIC), to buy up to 12.5% of Uralkali’s shares in 2014. No price was disclosed, but it is likely to have been at or above market value. That hit a peak of $43.49 per share on November 9; it had averaged $40 per share over the three months preceding the CIC deal. So this ought to have cost the Chinese $2.9 billion.

That outlay in convertible bonds is now worth $1.8 billion. Have the Kremlin, the Russian state banks, and Kerimov combined to pull such a costly surprise on Beijing? Or were the Chinese willing to part with their money in November at a billion dollars more than their stake is now worth, because they were assured that potash would become significantly cheaper for China to buy when the bond conversion into shares falls due in a year’s time?

The likelihood is that the Chinese government was an insider in this deal too – but in league with which side? The thinking in Minsk is that Lukashenko made his own deal with the Middle Kingdom when he visited Beijing on July 16. According to one Belarus source, “if you look at the rhetoric from Minsk over the last year it was clear that Kerimov was trying to force Lukashenko to sell Belaruskali. He has been to see Lukashenko in Minsk and even then the TV showed the grim faced Lukashenko lecturing Kerimov on the advantages of strategic cooperation. Obviously, they failed to persuade him.” When Lukashenko’s visit followed to to China in mid-July, “this looks to be the straw that broke the camel’s back.” That’s to say, the Russian camel.

According to an analysis by another source: “Given that Belaruskali announced its decision to sell its product by itself in December of last year, and Uralkali has been making arrangements to go solo for a few months now – they were already sending cargos out outside of the BPC earlier this year — why such a high-handed response by Uralkali only now? I can only speculate that Belarus President Lukashenko’s visit to China resulted in a contract signed outside of BPC, and this was the last stroke that broke Uralkali’s patience.”

The Belarus theory isn’t taking into account CIC’s stake in Uralkali. So unless the Chinese miscalculated that their deal with Lukashenko and Belaruskali would not have the costs Uralkali has now inflicted, the Chinese are now calculating that they will gain if they play both sides against the middle. The Chinese win with this strategy in the short term, because potash will cost them $200 less per tonne. In the medium term, they will gain on their equity investment if Uralkali successfully pressures Belarus into conceding control of Belaruskali to the Kremlin. In the long term, the Chinese might find themselves financing the enlarged potash monopoly for a stake of better than 12.5%.

How many insiders can fit inside the Kremlin wall? This June, six weeks before the strategic change, Mutsoev sold out his 6.4% stake back to Uralkali for $1.3 billion. At the time, Alexander Voloshin, once a mouthpiece for Boris Yeltsin and currently chairman of the Uralkali board, claimed Mutsoev, was selling his shares because “he wants to focus on public service”. Could Voloshin have been as blind, deaf and dumb as that sounds in retrospect? Or was he in on the scheme agreed with the state banks and with their Kremlin supervisors that Mutsoev would start his new focus on public service by sharing the multi-million dollar profit the insiders were guaranteeing?

Mutsoev wasn’t the only one — Nesis was also heading for the door. He had started by buying 13.2% of Uralkali during the elimination of Rybolovlev and Silivinit – a “warehousing operation” for him, an associate acknowledged at the time, with the understanding that he would be allowed to sell out slowly[11]. By August of 2012, Nesis was down to 9.9%; by April of 2013 he was holding just 5.1%. That too was sold out by July 26, according to a statement by Uralkali, when Nesis’s appointee on the board stepped down. Nesis and Uralkali agreed to say his exit had been “in several small stakes on and off the market, with buyers representing several portfolio investors.” Like Mutsoev, Nesis was also engaged in public service, according to the Uralkail statement[12], since “the funds received from the sale of shares will be used to finance projects in railway transportation.”

According to a spokesman for Nesis, the timing of his share sale and the collapse of the potash cartel is a “coincidence”. Nesis’s spokesman Nikolai Dobrinov used that word with his tongue firmly planted in his cheek. Nesis and Mutsoev have been insiders for several years, so there was almost certainly a prior obligation on the part of Uralkali to buy them out at an agreed profit margin, protecting their outlay risk if the market changed, or if they could not find an open market, arm’s length buyer for their shares. Nesis started earlier than Mutsoev; he may have made the larger profit. But if implementing the Kremlin strategy for the potash sector — devised originally by Igor Sechin when he was deputy prime minister in charge of resources and decided Rybolovlev had to be replaced — is public service, then that’s exactly what Mutsoev and Nesis have been fortunate to serve.

No source close to them, or to Kerimov and Voloshin, believes they have acted without advance agreement with the Kremlin. Without that, the state banks holding Uralkali shares as collateral for the company’s borrowings, as well as Kerimov’s, would have followed the July 30 announcement with margin calls. That hasn’t happened.

Their shared strategy to leave the BPC has now triggered a 47% decline of Uralkali’s share price from this year’s peak; it has taken down with it the share prices of all other potash producers, including K+S, the German multi-fertilizer group in which Melnichenko holds the largest stake. About half of Uralkali’s market capitalization, or $11 billion of shareholder value, has been lost.

At K+S the value burn has been €3.7 billion. In April K+S had announced it was delaying the start of a new potash mine in Canada, replacing its dwindling mines in Germany, because the Canadian costs had risen substantially. But the delay would be temporary, K+S also claimed, because it was forecasting no global increase in the volume of potash for sale, and thus relatively stability for the potash price. According to the K+S claims, it planned to invest in an extra 3 to 4 million tonnes of potash capacity; hang on to its 10% share in the global market; and earn “a 15 percent premium on the cost of capital before taxes”, according[13] to its chief executive Norbert Steiner.

Through three Bermuda front companies, 9.88% of K+S is owned by Melnichenko, and he is K+S’s largest shareholder. Since last week’s Uralkali move, he has lost €365 million in current stock value. But that’s only the start. If the Germans thought Melnichenko was their fixer in Russia, their early warning on their eastern front, they appear to have made a bad mistake. If the potash crisis was deliberately triggered by the Kremlin, on terms allowing some of the Russian stakeholders in Uralkali to escape with profit, is Melnichenko the biggest of the Russian losers? Or did he too strike an accommodation with the Kremlin in advance?

Uralkali’s move to stop cooperating with Belaruskali and increase annual production to 13 million tonnes next year from 10.5 million may reduce prices to less than $300 a tonne, according to Uralkali’s chief executive Baumgertner. That would be at least 25% below the latest contract price for China and the lowest since January 2010[14].

At that price level Melnichenko and Eurochem cannot start mining potash without making losses. As these two charts of the potash price show, the first for one year past, and the second for the previous seven years, it will be ruinous for Melnichenko and Eurochem if they bring their two new Russian mines onstream, and allow K+S to do the same in Canada, at the same time as Kerimov uses his new market power to force the potash price back to its historical level.

That, say Moscow’s institutional analysts, will have an immediate financial impact on Uralkali’s position with its banks. Uralkali’s loans totalled just over $4 billion on December 31, 2012, according to the company’s annual financial report[15]. The banks are not identified, but are believed to be led by the Russian state lenders. Reporting by Moscow financial institutions indicates that by June 30, the debt was $4.9 billion.

The picture for Eurochem is much worse. According to its 2012 annual report[16], it has been counting on besting Uralkali to become the leading producer in Russia of saleable “nutrient capacity”. This and other presentations have indicated a forecast of more than $1 billion in annual revenues from the potash mines, once they are operational. However, if the potash price drops below $300 per tonne, analysts are calculating that compared to the revenue projections, the company will lose about $1.8 billion. In short, it will be losing more money on potash than it has been counting on taking in sales – more money than it says it has invested to earn at one of its Russian mine projects. What happens then? If Melnichenko doesn’t produce potash at the Verkhnekamshoye and Gremyachinskoye mines by the 2014 deadlines in their licence agreements with the Russian government, will Melnichenko be able to negotiate an extension of the deadlines? Or will he face the same ultimatum Sechin gave Rybolovlev in 2009 – sell out, or be taken over? Given what Uralkali has already done to the potash price, the market price of Melnichenko’s exit from the potash sector will be much less profitable than Rybolovlev’s.

The Rencap analysis of Uralkali’s future since the July 30 announcement is positive towards Uralkali because “potash prices of around $300/t make nearly all greenfield and brownfield potash projects IRR [Investment rate of Return] negative and may force some marginal producers to idle operations. The reduced potash supply in the future may support potash prices later this decade, while Uralkali’s new strategy may help maximise its market share.” Eurochem, which isn’t covered by the institutions because it remains unlisted, is one of the apparent victims.

Non-Russian bank lenders to the potash sector, who aren’t in on VTB’s and Sberbank’s deal, appear to have worked this out. For that reason, they are now getting ready to raise their price for the abrupt increase in risk in lending to Melnichenko and Eurochem which has materialized. According to one report[17] last week, “EuroChem has sent out a request to banks for a soft target of $1bn, with banks asked to provide $100m-$150m each. The margin on the five-year unsecured deal is 180bp. This price has proven contentious among lenders as it is the same that the firm paid in 2011 for its secured pre-export finance facility. At least two of EuroChem’s relationship banks have decided not to lend to the firm on this deal because of the pricing. Last week [before July 30], one of the banks from the senior group told EuroWeek that they were not lending a top ticket this time around, citing the low pricing as the reason. Instead, the bank has returned to EuroChem with an offer of a much-reduced ticket, as a way of keeping the relationship open. But now another bank – also a senior lender on the 2011 PXF [Pre-Export Finance] – has told EuroWeek that it is dropping out altogether.” Several days before the July 30 shock, Euroweek’s sources among the Eurochem bank syndicate were admitting their reluctance to lend at Melnichenko’s proposed interest rate. Whether there is a price at which the remaining members of the syndicate will lend now remains to be tested by Eurochem’s negotiators over the next few days.

This is why Torin, Melnichenko’s spokesman, is so tight-lipped. When Eurochem issued its annual report[16] for 2012, it acknowledged the “threats” facing its potash strategy: “Prolonged, significantly worse-than-expected market conditions could negatively affect EuroChem’s ability to continue financing these investment projects… Significant capacity additions resulting in oversupply in the industry .” So Torin was asked: “At a potash price of between $200 and $300 per tonne, Eurochem’s previous statements regarding its two new potash mines in Russia, and its projects in Kazakhstan, suggest that these projects will be uneconomical, if not loss-making. Is that correct? What action does Eurochem intend in relation to its capital spending on the Gremyachinskoye and Verkhnekamshoye mines? Do you intend to delay commissioning these and the Kazakh projects until potash prices stabilize again above $400? Does Eurochem intend to prioritize the nitrogenous fertilizer segment of its business as a result of the changes in the potash market?”

No reply, not even an acknowledgement of receipt.

To this, Uralkali has already issued its response. “Consolidation”, said chief executive Baumgertner in Moscow this morning, “is the logical step when the price falls to the level of marginal producers.”